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February 22, 2010

Reverse Payments in Generic Drug Settlements

In its report on so-called "pay for delay"
settlements of ANDA litigation (otherwise known as "reverse payments"),
the Federal Trade Commission (FTC) is calling for an outright ban on such
agreements.Settlements containing
"reverse payments" involved payments from the patent- and
NDA-holding, branded drug company to a generic company that has filed an ANDA
containing a Paragraph IV certification that an Orange Book-listed patent is
invalid or unenforceable.

This pattern raises the question of whether it may
be the FTC that is "misapplying" the law by demanding a per se rule holding reverse payments to
be illegal.Since the FTC's
position is completely goal-oriented (because the result of these agreements is
a delay in generic competition), reviewing the bases of these several Courts of Appeals decisions seems warranted.

As it turns out, the Courts' views are considerably
more nuanced and thoughtful than the FTC's rhetoric.In the 11th Circuit case, the FTC issued a "cease
and desist" order prohibiting Schering-Plough from settling any patent
infringement lawsuit with a generic drug company where Schering-Plough gives
the generic company "anything of value" and "agrees to suspend
research, development, manufacture, marketing or sales of the generic product."The basis of the order was the
Commission's determination that the settlement agreement between Schering-Plough and Upsher Pharmaceuticals
(containing a reverse payment) was an unreasonable restraint of trade in
violation of 15 U.S.C. § 1 (Section 1 of the Sherman Antitrust Act) and Section
5 of the FTC Act (15 U.S.C. § 45(a)).The product at issue was an extended-release formulation of a potassium
supplement claimed in U.S. Patent No. 4,863,743.Schering-Plough filed suit in response to Upsher's ANDA
filing on a generic version of Schering-Plough's formulation product, and the
parties settled before trial.The
agreement contained a $60 million initial licensing fee, $10 million in
milestone royalty payments and 10-15% running royalties on five drugs owned by
the generic company, including an anti-cholesterol drug having an estimated net
present value of $250 million.In
addition, Upsher agreed to a compromise date for market entry of it generic
potassium product.(In a related
case, Schering-Plough sued ESI-Lederle on the same patent, with a
court-mediated and approved settlement having an agreed-to delayed market entry
date for the generic product and a reverse payment from Schering-Plough to
Lederle.)

Initially, the Administrative Law Judge hearing the
case in the first instance found both these agreements legal and dismissed the
FTC complaint.The ALJ's reasoning
was that, unless the patent was invalid or if the generic products did not
infringe, the agreements were not violations of the antitrust laws.Significantly the FTC adduced no
evidence before the ALJ that these agreements were anything other than arm's-length
transactions between the parties.The ALJ found that the FTC did not prove that, without the payment,
either a better settlement agreement or litigation would have resulted in
earlier generic market entry.

The case was then heard by the full Commission, who
reverse the ALJ.The Commission
backed off its initial position that reverse payment agreements are per se illegal, but held that the quid pro quo of payment was for delayed
generic market entry, which delay "would injure competition and consumers."The Commission based its decision on generic
market entry that "might have been" agreed upon between the parties
in the absence of payments.Even though the Commission couldn't tie the entry dates to the monetary
compensation, it developed the rule that reverse payments were illegal, with
an exception for litigation costs to be capped at $2 million and a requirement
that the FTC must be notified of the existence and terms of the agreement (a
requirement adopted in the 2003 Medicare Prescription Drug Improvement and
Modernization Act).

The 11th Circuit reversed, in an opinion that gave
less deference to the Commission's decision that it might have otherwise,
absent the different results before the ALJ and the Commission as a whole.The Court made its determination in
view of an earlier 11th Circuit case, Valley Drug Co. v. Geneva Pharm., Inc., 344 F.3d 1294, 1303-04 (11th Cir. 2003).In that case, the Court reversed a
district court determination regarding an interim settlement agreement between a branded
pharmaceutical company and a generic containing a monthly payment ($4.5
million) from the branded company to the generic that kept the generic drug off
the market until the underlying patent infringement suit was concluded.The district court found this per se
anticompetitive. The Court of Appeals
reversed the district court's determination that this agreement was per se
illegal, based on the exclusionary nature of the patent.Patents, according to the Court, intrinsically
distort the competitive landscape, and thus defeats a determination that the
agreement was per se illegal: "In the context of patent litigation . . . the
anticompetitive effect may be no more broad than the patent's own exclusionary
power. To expose those agreements to antitrust liability would 'obviously chill
such settlements.'"

The FTC did not use a per se standard against
Schering-Plough, however, but instead applied a "rule of reason"
analysis.The rule "tests 'whether
the restraint imposed is such as merely regulates and perhaps thereby promotes
competition or whether it is such as may suppress or even destroy competition,'"
citing FTC v. Indiana
Federation of Dentists, 476 U.S. 447,
457 (1986), quoting Board of Trade of City of Chicago v. United States,
246 U.S. 231, 238 (1918).Here,
the Commission differed from the ALJ merely be showing "a detrimental
market effect," which the Court characterized as "a low threshold"
for making a finding of antitrust liability:

Thus,
under the Commission's standard, once the FTC met the low threshold of
demonstrating the anticompetitive nature of the agreements, it found that
Schering and Upsher did not sufficiently establish that the challenged
activities were justified by procompetitive benefits. Despite the appearance
that it openly considered Schering and Upsher's procompetitive affirmative
defense, the Commission immediately condemned the settlements because of their
absolute anti-competitive nature, and discounted the merits of the patent
litigation. It would seem as though the Commission clearly made its decision
before it considered any contrary conclusion.

The Court stated that when patents are involved, neitherper se illegality nor rule of reason analysis is appropriate in
assessing antitrust liability, due to the "legitimate effects on
competition legally available to the patentee":

By
their nature, patents create an environment of exclusion, and consequently,
cripple competition. The anticompetitive effect is already present. "What is required
here is an analysis of the extent to which antitrust liability might undermine
the encouragement of innovation and disclosure, or the extent to which the
patent laws prevent antitrust liability for such exclusionary effects." Valley
Drug Co. v. Geneva Pharm., Inc.. Therefore, in line with Valley Drug,
we think the proper analysis of antitrust liability requires an examination of:
(1) the scope of the exclusionary potential of the patent; (2) the extent to
which the agreements exceed that scope; and (3) the resulting anticompetitive
effects.

It is the legitimate
exclusionary power of the patent, that the Court said must be considered in
making an antitrust determination."Although the exclusionary power of a patent may seem incongruous
with the goals of antitrust law," the Court said, "a delicate balance
must be drawn between the two regulatory schemes. Indeed, application of
antitrust law to markets affected by the exclusionary statutes set forth in
patent law cannot discount the rights of the patent holder.Simpson v. Union
Oil Co., 377 U.S. 13, 14 (1964). (Patent laws 'are in pari materia with the
antitrust laws and modify them pro tanto (as far as the patent laws go)).'"

Turning to the patent at issue and the agreement
between the parties, the Court noted that the FTC's characterization of the
agreements as linking the payments to the delayed market entry (which "raised
a red flag" according to the FTC) was not supported by substantial
evidence.Indeed, in the
proceedings before the ALJ, FTC counsel "acknowledged that it could not prove that Upsher and ESI could have
entered the market on their own prior to the '743 patent's expiration on
September 5, 2006. This reinforces the validity and strength of the patent."Indeed, the Court found that the
evidence before the ALJ was directly contrary to the FTC's position -- that
Schering-Plough's personnel evaluating the value of the license of Upsher's
products were "unaware of" the litigation, and the reverse payment
was "a bone fide fair-value payment" for rights to market these drugs
(particularly the anticholesterol drug).The Commission credited a staff economist (purportedly an "expert"
in pharma industry licensing) who testified that the reverse payment amounts
were "grossly excessive."The Court was unimpressed:

We
are troubled by [expert] Levy's testimony. Interestingly, Levy arrived at his
conclusions without performing a quantitative analysis of Niacor [the
anticholesterol product] or any of the other Upsher products licensed by
Schering. Additionally, Levy lacked expertise in the area of
cholesterol-lowering drugs and niacin supplements. Finally, Levy's unpersuasive
appraisal of the post-settlement behavior blatantly ignored the parties'
ongoing communications and the fact that the niacin market essentially bottomed
out.

The Court found even
less evidence for the Commission's decision with regard to the Lederle
agreement -- the FTC presented no factual witnesses and "little"
expert testimony (and "spent little time" in its opinion and order justifying
its conclusions).

The Court said "[t]he FTC did not rebut [Schering-Plough's] testimony,
but rather ignored it," and that "all of the evidence" supports
the ALJ's conclusion that the settlement did not contain a "naked payment"
merely intended to delay generic entry.The 11th Circuit also noted that the Supreme Court has endorsed the practice
forlitigants in a patent lawsuit
to "exchange consideration to settle their litigation" without any
antitrust liability, citing Standard Oil Co. v. United States, 283 U.S.
163, 170-71 n. 5 (1931), and the 11th Circuit notes a general policy position that encourages
settling litigation.Affirming the
Commission's decision, the Court said, "wouldleave settlements, including those endorsed and facilitated
by a federal court, with little confidence."

Turning to the
allegations that the agreement violated the FTC Act, whether the agreements
represented an "unfair method of competition," the Court
said that this requires that there be an actual anticompetitive effect, not one
that is "hypothetical or presumed."The Court based its decision in part on the limited effect
of the agreement, to the specific controlled-release potassium chloride
formulation and limited in scope to the extent of the exclusionary right stemming
from the patent.Interestingly, the Court opined that the certainty resulting from the settlement would lead to "more
intense competition." Citing Valley
Drug, the Court fashioned the idea that litigation can be a more costly
means to achieve the same exclusion reached by settlement, contrary to the "logic"
employed by the Commission that payment was merely a quid pro quo for delayed
generic market entry.

The Court's opinion also contained an interesting
analysis regarding the effects of the Hatch-Waxman Act:

It
is uncontested that parties settle cases based on their perceived risk of
prevailing in and losing the litigation. Pre-Hatch-Waxman, Upsher and ESI
normally would have had to enter the market with their products, incurring the
costs of clinical trials, manufacturing and marketing. This market entry would
have driven down Schering's profits, as it took sales away. As a result,
Schering would have sued ESI and Upsher, seeking damages for lost profits and
willful infringement. Assuming the patent is reasonably strong, and the parties
then settled under this scenario, the money most probably would flow from the
infringers to Schering because the generics would have put their companies at
risk by making infringing sales.

By
contrast, the Hatch-Waxman Amendments grant generic manufacturers standing to
mount a validity challenge without incurring the cost of entry or risking
enormous damages flowing from any possible infringement. See In re
Ciprofloxacin Hydrochloride Antitrust Litigation, 261 F. Supp. 2d 188, 251
(E.D.N.Y. 2003). Hatch-Waxman essentially redistributes the relative risk
assessments and explains the flow of settlement funds and their magnitude. Id. Because of the Hatch-Waxman scheme, ESI and Upsher gained considerable leverage
in patent litigation: the exposure to liability amounted to litigation costs,
but paled in comparison to the immense volume of generic sales and profits. This statutory scheme could then cost Schering its patent.

By entering into
the settlement agreements, Schering realized the full potential of its infringement
suit -- a determination that the '743 patent was valid and that ESI and Upsher
would not infringe the patent in the future. Furthermore, although ESI and
Upsher obtained less than what they would have received from successfully
defending the lawsuits (the ability to immediately market their generics), they
gained more than if they had lost. A conceivable compromise, then, directs the
consideration from the patent owner to the challengers. . . . Ultimately,
the consideration paid to Upsher and ESI was arguably less than if Schering's
patent had been invalidated, which would have resulted in the generic entry of
potassium chloride supplements.

Following this line of reasoning, the Court posed a
"pre-Hatch-Waxman" hypothetical regarding settlement of a similar
lawsuit, wherein if the patent-holder settled for less than the damages it was
entitled to, the "windfall" garnered by the generic would be like the
reverse payment here (since presumably the settlement would effect a delay in
generic market entry).And looking
long-term, a ban on reverse payments would remove the incentive for settlement,
and in some percentage of the cases the patentee would prevail, thus delaying
generic market entry even longer.Accordingly, the Court says that the anticompetitive cost to consumers
of litigation needs to be considered.

Finally,
the caustic environment of patent litigation may actually decrease product
innovation by amplifying the period of uncertainty around the drug manufacturer's
ability to research, develop, and market the patented product or allegedly
infringing product. The intensified guesswork involved with lengthy litigation
cuts against the benefits proposed by a rule that forecloses a patentee's
ability to settle its infringement claim.See In re Tamoxifen Citrate
Antitrust Litig., 277 F. Supp. 2d 121, 133 (E.D.N.Y. 2003) (noting that the
settlement resolved the parties' complex patent litigation, and in so doing, "cleared
the field" for other ANDA filers). Similarly, Hatch-Waxman settlements,
like the ones at issue here, which result in the patentee's purchase of a
license for some of the alleged infringer's other products may benefit the
public by introducing a new rival into the market, facilitating competitive
production, and encouraging further innovation.

The 11th Circuit's decision thus appears to be
squarely within the boundaries of appellate court review of administrative
agency decisions.The Court found
the Commission to have ignored or discounted evidence contrary to its inclination
to find that settlement agreements containing reverse payments constitute an
antitrust violation, and rejected its legal determinations that the specific agreement at issue in this case was improperly
anticompetitive (i.e., outside the scope of the legitimate exclusionary
scope of the patent grant).

An analysis of the other instances where the FTC
considers appellate review contrary to its decisions to be a "misapplication
of the laws" will be set forth in later posts.